Posted 4 years ago on Jan. 5, 2012, 1:44 a.m. EST by ARod1993
(2420)
This content is user submitted and not an official statement

The current conception of an ideal market is based around the model of supply and demand; this means that the prices and quantities of the goods we buy depend on how much it is possible to produce, how much people are willing to buy, and at what price people are going to buy it. Such a market is perfectly efficient, and one could argue that it is also perfectly fair. Attempting to interfere with this market will in fact decrease its efficiency and ruin it for both the corporations and the consumers.

What people don't realize is that this model depends on several underpinning assumptions, and when these assumptions are not met then you no longer have an ideal free market. There are three major assumptions that must hold true for an ideal market to exist:

1) No single company or business is big enough to affect the equilibrium price and quantity (that means that businesses have to follow the market because they can't really affect how it operates)

2) Anyone who wants to enter the market (start a business) can do so fairly easily, and can leave the market (shut down) just as easily.

3) All costs of production (including things like pollution caused by the manufacturing process) are accounted for in the purchase price.

If you look at most major industries today you'd be very hard-pressed to find a market in which even one of these assumptions holds true, let alone all three. First of all, when corporations reach a certain size you either get what's called an oligopoly, which means that a handful of firms control almost all of the share in a given market, or you get a monopoly in which one firm controls the entire market. This effectively negates Assumption #1, because the firms are big enough to manipulate the market size and shape as they choose, and thus the market is no longer free from outside influence.

Also, once firms get to a certain size it becomes almost impossible to enter the market in any real way. Economies of scale make it much easier for an existing large firm to mass-produce goods at fairly low costs. Someone new who seeks to enter the market will never be able to create a company from scratch that's big enough to match the old firm's economy of scale, and if they start small they'll start off with higher per-unit costs and (by necessity) higher prices than established firms. This makes them fairly easy to run out of business while they're still small, thus invalidating Assumption #2.

The third assumption is almost never valid in our current situation when you think about it, because there are certain side effects to many large manufacturing operations that the corporations themselves never have to address. If you manufacture a good, but the process produces toxic chemicals, then that's a side effect. In many cases, the chemicals are simply released into the environment, causing damage to the local ecosystem and occasionally direct harm to other people. This damage is called an externality, which means that it's a portion of the cost of production that is quietly foisted on everyone whether they like it or not, and more often than not it's simply treated as part of the cost of being alive.

Here's the thing; left to their own devices corporations will inevitably externalize as much of their costs as they possibly can (to increase market share and profits), and eventually most markets will devolve into some form of monopoly or oligopoly, which causes the problems I described above and leads to the kinds of abuses that caused the 2008 economic crisis. Someone or something has to actively work to preserve the free market by breaking up monopolies and forcing companies to stop externalizing their costs, or free markets are no longer free or efficient.

As paradoxical as this may sound, you can't have a truly free market without an outside entity (usually the government) actively fighting to keep it in that state. When we say that we want more regulation, we're not trying to strangle the little guy; we're actually clearing off the playing field so that he can rise or fall solely on the success of his product rather than on who he knows or how much disposable income he has or what he can get away with dumping into the air and water. If you want to make free markets free you have to guard their freedom, and the only safe way to do that is through the government.

Price-fixing. Let's take Apple for example (just for fun). They have a tablet which they sell for a certain price... 400 if I recall correctly. YOU claim they have the power to fix that price because they've grown so large.

Except that's not true. Apple's tablet has been undercut by a new competitor selling the Kindle Fire tablet for a mere $200. And just yesterday I heard open-source Android tablets can be bought for 50. Apple will eventually be forced (by the free market of consumers) to lower their prices.

You also claim that corporations exert enormous power to maintain their domnance. But that's not true either.

Back in the 1980s the biggest retailers were Kmart (discount) and Sears (middle income). Now it looks like these two giants haad a lousy year and are heading to bankruptcy. In fact a LOT of big names have disappeared lately. Montgomery Wards. Circuit City. They failed to keep the consumer happy, so the consumers exercised their FREE MARKET choice to vote with their dollars, and drive these big entities into (or close to) bankruptcy.

The final think you claim is that companies will dump their chemicals.

I think we already fixed that problem with the EPA. Just as the government protects our rights to not be killed, or assaulted, or property stolen, it is also acting to protect our clean air and water (necessary for the continuation of each individual's life).

And now I'll add my own thought:

The market is the purest form of democracy we have. Each person casts votes and they do so with their wallets. When I buy an Android Tablet, I'm sending a message that I want a low-cost be open product (rather than Apple's closed limited design). When I get a call from Comcast to sign-up for their TV service and I say "F ff" tht sends a message too. It says I don't think I should have to pay for TV (at least not at the outrageous 80/month they charge).

The free market empowers the People.

No it isn't prfect but it's certainly better than a Soviet-style government run market where people don't get a vote (except once every 2 years). I like the Free market because it puts power in MY HANDS to decide what products I want (or don't want) to buy

1) I'll give you that the specific scenario you described is fairly typical of parts of the hi-tech industry, but I'd argue that this is the exception rather than the rule. As it stands now, certain end-user technologies like tablets are evolving fast enough that the market is evolving too quickly to get a handle on and so price-fixing isn't really feasible. That said, I can hand you a counterexample from a different subset of the same industry: Intel and AMD.

In the US (and as far as I can tell the world) there are really only two firms from whom computer manufacturers and do-it-yourselfers can obtain quality CPUs: Intel and AMD. The way it works is that AMD takes the bang-for-the-buck share of the market, and Intel takes the area interested in pure performance. The result of this is that Intel can charge whatever it wants for any CPU above a certain cutoff, and there's a good-sized jump in price right around that cutoff. On the really high end you wind up with year-old tech that can't quite keep up with the new $350 offering being priced as $900+, and that price never falls.

2) That's not some great victory by the consumer made possible by the free market, that's what happens when ordinary Americans get nailed by a bad recession. There's simply not enough disposable income in the market anymore to move enough product to support all of the retailers in the market, and someone's got to take the hit. Generally the little guy gets nailed first because there's only so low he can drop his prices; the fact that the recession is hitting the big boys is a testament to how tough things are.

3) The EPA does its best, but it's only able to address a fairly narrow range of situations because it's understaffed and also underfunded. If the EPA were fully able to protect the interests of the general populace then there would have been some serious federal action on their part regarding factory farming (I'm not kidding here; Google "shit lagoon and you'll see what I mean). The other thing is that the EPA is often erroneously assaulted as overstepping its bounds and this year alone Rand Paul tried to nullify the Clean Air Act, effectively destroying the EPA's ability to prevent truly ugly air pollution.

You are wrong about Intel and AMD. There are other firms like National Semiconductors, TI, Cyrix, transmeta etc which also sell processors. Not necessarily desktop but they are into a lot of other things. Also Intel and AMD are always at price war driving prices down all the time

On the contrary it happened because these firms could keep their cost down and streamline their supply chain.

Well is Intel price-raping the consumer (us)? No not really. They remember what happened in the 90s when numerous competitors popped-up and started cloning their 486s and Pentiums
.
You see when any company becomes abusive of the customer (raising prices), then a new competitor will come-along to replace them. Even now Intel still has to deal with competition from other CPU manufacturers who are outselling them in the Cellphone and Tablet and Game console markets. -- Intel is faaaaaar from being a monopoly when you look at the whole electronic industry. They could easily end-up like Kmart (the walmart of the 70s/80s but now nearly bankrupt).

.

Anyway you oppose the free market, whereas I see it as the purest form of democracy. I can tell Comcast or Intel or Microsoft to "fuck off" and get away with it. That's FREEDOM in a nutshell. If I tried that with my Democrat Congressman I'd probably get arrested under the Patriot Act & shipped to Gitmo as a "terrorist". Or maybe they'd just raid my house on some trumped-up excsue

You see I FEAR my government, but I don't fear the sbhitrholes that run our corporations. They lack an army or police force to abuse me

The EPA can only regulate what Congress allows them to regulate. If Congress has not authorized them to abolish "shit lagoons" then the EPA can not act. (Similarly the FCC cannot censor language on cable tv, because Congress never gave the authority.)

I need a citation for your claim that Congressman Paul tried to "nullify" the clean air act. From what I've read he was opposed to the EPA's labeling of CO2 a pollutant, and I agree with him. CO2 is a key component of life on this planet -- not a pollutant. CO and NOx and HCs and PMs are certainly pollutants (they damage human lungs), but not CO2.

False statement. During the age of the dinosaurs there was twice as much CO2 as we have now, and it didn't harm the atmosphere one bit. Please take a moment to think about what you're writing before you post it.

Also where's your citation to back-up your false claim that Congressman Paul tried to kill the Clean Air act? (I shall assume you have none, and your claim is false.)

Too much CO2 is harmful. Some people use this knowledge to commit suicide. They let their car run in a closed garage to load the air with CO2. All life on earth depends on the makeup of the atmosphere. Too little or too much CO2 would and could create havoc.

During the age of the dinosaurs there was twice as much CO2 as we have now, and it didn't harm the atmosphere one bit.

It's not about harming the atmosphere, it's about harming life that depends on that atmosphere.

Also where's your citation to back-up your false claim that Congressman Paul tried to kill the Clean Air act? (I shall assume you have none, and your claim is false.)

Please take a moment to read before you reply with a comment. I never talked about congressman Paul trying to kill the Clean Air Act. If you think I did, please tell me where. I have no recollection of ever writing about this.

Too much CO2 is harmful. Some people use this knowledge to commit suicide. They let their car run in a closed garage to load the air with CO2.

ALEX JONES?

Is that you??? You sound just as nutty.

It's not about harming the atmosphere, it's about harming life that depends on that atmosphere.

Now you're starting to make sense. Except it isn't CO2 that harms life. It's lack of oxygen and we have tons of it, so you need not worry. Besides CO@ makes the plants grow. The more CO2 the happier the plants will be! (hugs a tree)

Your view is extremely simplistic. A destabilization of the atmosphere could cause havoc on earth. Read some scientific journals for a change. You're the one spending too much time on Alex Jones type sites.

As I mentioned before, the CO2 was twice what it is now, and it didn't harm the dinosaurs or the proto-mammals one bit.

Vice-versa too much oxygen IS dangerous. 300 million years ago, when animals were still primitive (spiders and insects), the atmosphere was literally explosive. I'd rather have too much CO2 then too much O2.

actually those who commit suicide in their garages aren't killed by CO2, they are killed by CO (Carbon Monoxide) which binds to the hemoglobin much more readily than oxygen, and prevents oxygen from entering the bloodstream...

It seems you've been reading conspiracy theory websites. Iv'e learned it's impossible to debate such thinking, so I'll leave you alone with that. If you ever want to see the other side of the coin, I suggest you read the many articles on Global Warming that have been published in peer-reviewed scientific journals.

Just because that is the answer you unscientific fools always come up with..... "peer-reviewed" is not science...it's consensus, consensus is not science...experiment and consistent empirical evidence is......anthropological climate change is a hypothesis...it hasn't even created enough evidence to become a theory yet.....maybe YOU should spend some time off the conspiracy theory websites...hahaha

why don't you source some of these "peer-reviewed scientific journals"?

It is impossible to debate the truth with lies, and facts with speculation.....that is what you numbskulls find impossible...

Spot on ARod1993. What is surprising is that it has taken this long for people to realise the illusion of a free market. The issue of assumptions that you refer to is crucial to the sustenance of this illusion. Indeed the basis of the sub-prime crisis, the so-called Collateralised Debt Obligations, was premised on a series of assumptions that the creators knew very well were dead wrong, but which they successfully convinced regulators it didn't matter anyway if they're not satisfied. The theory lives on.

Some years ago when I began a Master’s degree in financial the first book I laid my eyes on was ‘Derivatives: Theory and Practice of Financial Engineering’ by Paul Wilmott. It was no coincidence. As one of the great evangelists of the elusive science of money, St Paul commands rock star celebrity status among the moneyed elite of Wall Street. And, as financial engineering goes, nothing is more central than the Black-Scholes-Merton model, the Genesis of it all. But at the very beginning of the chapter that should have elucidated on this most bizarre of sciences, Paul starts with a surprising confession. Verbatim, the introduction reads:

“This is without doubt the most important chapter in the book. In it I describe and explain the basic building blocks of derivatives theory. These building blocks are delta hedging and no arbitrage. They form a moderately sturdy foundation to the subject and have performed well since 1973 when the ideas were made public….This chapter is quite theoretical, yet all the ideas contained here are regularly used in practice. Even though ALL of the assumptions can be proven to be wrong, to a greater or lesser extent, the Black-Scholes model is profoundly important both in theory and in practice.”

Even at that early stage, I could tell that this was set to be an interesting lecture indeed. But it was only when I got to the actual assumptions underlying the ubiquitous methodology that it dawned on me I was being let on to something far more important. Below is how the assumptions were presented, again straight from the stable:

The underlying [asset] follows a lognormal path: This is not entirely necessary.

The risk-free interest rate is a known function of time: this restriction is to help us find explicit solutions.

There are no dividends on the underlying: I will drop this restriction in a moment.

Delta hedging is done continuously: This is definitely impossible.

There are no transaction costs on the underlying: The dynamic process of delta-hedging is in reality expensive since there is a bid-offer spread on most underlying.

There are no arbitrage opportunities: This is a beauty. Of course there are arbitrage opportunities; a lot of people make a lot of money finding them.

And then he rounds off the section with a real stinker: “There are many more assumptions but the above are the most important. In other parts of the book I will drop these assumptions or, if I don’t drop them I will at least loosen them a bit.” What? I sympathise.

If you’re confused as to what Paul is talking here, worry ye not. You’re not the only mortal unable to comprehend the language of the angels. As a fallen angel myself, let me translate. Word for word, here goes:

“Look here kids. The above are the ludicrous inputs into our make-believe model, but over the coming few chapters I will take every opportunity to rubbish, disregard, spit and trample on these inputs, before chucking out the most offensive bits out of the window. Any remaining stubborn stains I will just ignore. In other words kids, let’s invent the perfect crime to suit the grisly crime scene we just staged, a scene that marries perfectly with the harsh punishment we have prepared for the culprit we already have in mind.”

As we all know now, what followed is now a matter of serious academic curiosity.

It's your lack of education mate that has failed you. Financial engineering is voodoo science ,it doesn't work mate! Economics is not physics, it doesn't follow any rules. That's what this crisis talk us; shame there are many like you who're hell-bent on ignoring the lessons. Hiring hardcore scientists to solve economic problems is the equivalent of using the nuclear bomb to kill a fly. It is the same as deploying the full force of a sledgehammer to crack a nut. Sure enough, you’re likely to completely obliterate the tiny enemy, but then you’re going to be stuck with an elephant-sized problem on your hands. And, after the hammer has done its job, the only thing left to savour is likely to be the unpleasant smell of burnt peanuts. We called our burnt peanuts The Credit Crunch.

I am sorry to say but your education seems to have failed you. Black Scholes is not a perfect formula, Wilmott is clear about that. it's a mathematical approximation, a tool for thinking. It's your job to fit that formula to your needs. If it was just about plugging values into a formula, why would any firm hire you? A computer can do that.

Just like Black Scholes, even Newton's first law holds various assumptions which are not true in real life. Do you want to do away with that too?

The ultimate government in a free market are the buyers by their ability to say no, the price is too high. If the buyers had the knowledge of what a product is really worth, not what they are brainwashed to believe, there would be much greater equity in the marketplace. Knowledge equals power equals wealth.

The market does not work that way. People value items based on not what it cost to make them but on how much they value it. Do you think I don't know what my car might have cost to make? I know that the German manufacturer is charging a huge brand premium and I am ready to shell out the price.

The market doesn't work that way because people are brainwashed by continual commercial advertising and don't have a clue how much things really cost. A 1Lb. box of cereal that sells for 3$ only contains 11-12 cents of grain. More is spent on advertising than any other ingredient. Knowing this, would the average person continue to value their cereal so high?

It takes approximately 10 Lbs. of grain to produce 1 Lb of beef. At the same markup as cereal, beef should cost $30 a Lb. Cereal is one of the poorest values for the money. A 2 lb bag of brown rice costs $2, but only contains 30 cents of grain. Almost no advertising costs here.

I understand what you mean, and you'd probably like a number of the policies that follow from this rationale. I put this here primarily to put forth a reason why the policy path advised by corporate lobbyists and libertarians alike (further deregulation and privatization of our society) is not a panacea for our ills and will in fact make things worse while remaining within the philosophical framework of my opponents.

I think the system in place for the past 30 years has be able to run at all due to massive government intervention. We would not have been able to turn China into the worlds manufacturing king without fed polices that allowed banks more and more leverage, dumping huge amounts of cash into the system without the productivity to back it up. We had a dictator fed chief Greenspan since 1987, he's the guy who controlled the money supply and until we built up so much risk that the system collapsed all of our presidents loved him. He successfully covered up our decline. Without a constant inflow of cash we would have needed to face the reality of job loss due to outsourcing, instead we believed the myth that we could just open more and more retail stores to sell each other Chinese made junk. Bank leverage went from 7 or 8ish to about 30. during the reign of Greenspan -- not to mention the law changes that allowed other forms of excessive risk taking.
I'm not a libertarian, I probably sound like one, I'm not anti fed I'm anti Greenspan, his economic experiment has been conducted in a highly manipulated market ----not a free market.

okay I see, but your rationale focuses primarily on the market side of the equation .. with competition of markets , and not on the consumers side. realistically the consumer wants the large corporations for their ability to produce products at lower rates .. it just makes monetary cents.. but you have good logic otherwise , especially in your bottom line scenario where the environment pays the price in order for markets to gain higher profits .. this is a tough one to overcome.. A while ago divers had to search the nearby lake and they found many barrels of waste oils dumped off the side of the dock.. a horrible scene to the environment .. but truely shows how decisions are made when it comes to market profit.. I have no compassion for markets .. and the sooner we remove them the happier I will be.

“We are all at a table together, deciding which rules to adopt, free from any vague constraints, half-remembered myths, anonymous patriarchal texts and murky concepts of nature. If I propose something you do not like, tell me why it is not practical, or harms somebody, or is counter to some other useful rule; but don't tell me it offends the universe"~Jonathan Wallace

--isn't it time to move beyond the vague, murky invisible hand concept---

Exactly; the point of my post is that blind faith in a particular model gets us nowhere, and the invisible hand is not some sort of all-powerful deity. It does exist, but it can't exactly protect us when the entities it's supposed to be guiding have cuffed it to a bedpost in a search for greater profits. Markets work quite well within a given set of constraints, and the problem with where we are now is that we stripped out those constraints in a search for easy money rather than accept them as the price of a functioning society.

Well written post. I mostly agree with everything, but there are a few nuances you fail to mention.

Big companies have obvious advantages like the power to buy and produce in bulk and a bigger influence on the market, but those advantages come with a loss of flexibility and adaptability. Times change, and when they do small companies have the chance to sneak in because they are more flexible and adaptable. We've seen how the Bay, Eaton's, and Sears took big hits even though they were huge. We've seen Google go from a two man team to a huge company even though at the time they began there were already big players like Microsoft and IBM in their field.

We also have to note that being very big doesn't mean you can get the job done. Look at Microsoft. They are huge, but they have failed time and time again in the last decade. They haven't been able to infiltrate a new market and still rely on Windows and Office for the bulk of their sales. Their huge resources doesn't guarantee that they can make a product that people will want to buy.

You are wrong on so many counts. Economics does not only talk about free markets, it talks about monopolies, oligarchies etc as well as monopsony. And no market is 'free' in the text book sense of the word just as Newton law is only valid with perfectly shaped bodies in a vacuum and uniform resistance.

Also nowhere does it claim that environmental cost (or any negative externalities) are accounted for in the cost of production. They aren't.

Most industries are fairly competitive. In FMCG you have Unilever, P&G, Colgate-Palmolive and many others fighting it out. In IT services, you have a host of firms, both American, European and Indian which compete aggressively. In retail banking, there are thousands of banks. In investment banking, trading, or any other financial services, there are countless firms with none holding any sort of monopoly power (or oligopoly). In automobile, we have American , European and Japanese firms. In telecom too there are many firms. In consulting, you have the big 5 and then many others. In fact you will be hard pressed to find industries where there exist any monopolies or oligopolies. Oil may be one. Computer operating system is another where Windows dominates and that is because of network effect. Facebook is a monopoly in social networking and Google could be called a monopoly in search and both are so because of network effect.

Assumption #2 is also not made. Barriers to entry is a common concept taught in Econ 101.